A second mortgage is a mortgage loan that is secured by real estate that already has a mortgage on it. It is called a “second” mortgage because of where it is in line to be paid in case of foreclosure. In foreclosure proceedings, liens on the property (like mortgages) are paid off in order of seniority. The first mortgage on the property will be paid first, and the second mortgage will be paid after the first mortgage is paid.
Where first mortgages use the property as collateral for the loan, second mortgages often involve borrowing against the equity in your home. Equity is calculated by your loan to value ratio — the difference between the market value of your home and what is currently owed on the home.
Why Do People Take Out Second Mortgages?
There are a variety of reasons for people to take out second mortgages on their homes. In some cases, people use the funds from the second mortgage to pay off credit card debt or other types of debts. This allows them to save money, as the second mortgage may often have a lower interest rate than credit card rates.
Other reasons to take out a second mortgage include financing home improvements, such as renovations, and obtaining additional financing for business loans. Some people also include a second mortgage as part of their home buying process in order to avoid private mortgage insurance (sometimes called PMI). Depending on the lender’s requirements, a second mortgage may be used to “piggyback” on the first mortgage in order to make a sufficient enough down payment on the home that does not require PMI.
While interest from second mortgages used to be tax deductible in a wide variety of cases, recent changes to tax laws require you to use the money for “substantial improvements” to a home. This allows you to qualify for tax deductions based on the interest of the second mortgage.
What Types of Second Mortgages Are There?
Generally, the types of mortgage offerings are the same for second mortgages as they are for first mortgages. You can find a variety of loan offerings by talking to a qualified mortgage broker or mortgage lender. Second mortgages may be fixed-rate or adjustable rate, depending on a variety of factors including your debt to income ratio, the amount of equity you have built up in your home, and your mortgage needs.
Keep in mind that typically the interest rates for second mortgages tend to be higher than those for first mortgages, and that the amount borrowed will usually be lower than the first mortgage.
What About HELOCs?
Home Equity Lines of Credit (also called HELOCs) are sometimes referred to as second mortgages, although they are slightly different. Both types of loans use your home’s equity as collateral, and both will show up on your credit report and in a title search performed by a real estate attorney. However, a HELOC works as a revolving line of credit instead of a one-time static withdrawal.
While a second mortgage has a fixed loan amount with a fixed repayment term over the course of the life of the loan, a HELOC works a little bit differently. A HELOC allows you to draw out money up to a maximum amount. You don’t owe the lender anything until you make the withdrawal on the credit line, which means monthly payments depend on whether you have an outstanding balance on the credit line — in some ways similar to a credit card.
You also have the option to withdraw the funds in one lump sum or at multiple times until you reach the maximum amount. You may also have the option to repay and borrow over again, as long as you remain within the maximum amount of the credit line.
What Kind of Credit Do I Need For a Second Mortgage?
Just like with first mortgages, there are many loan programs out there to fit your needs. Depending on your credit history and the amount of equity you have in your home, you may be able to borrow more against the equity in your home. The more equity you have and the better your credit score, the better your chances of finding a loan program that is right for you.
Generally speaking, most second mortgage lenders will require a certain minimum credit score as well as records showing that you are current on your first mortgage payments. Other requirements can be discussed with the individual lender that you are working with.
Should I Talk to a Real Estate Lawyer?
If you are considering a second mortgage on your home, it is a good idea to speak with a qualified real estate attorney. The right attorney can help you by explaining different financing options depending on what your needs are, and what you can expect out of the process of taking out a second mortgage.
Your attorney can also perform a title search on the property as required by the lender, review your loan documents with you, and advise you regarding your obligations under the loan and the best way to move forward.